EEMEA: Russia-Turkey tensions dominates

The downing of the Russian jet by Turkey last Tuesday heightened significantly the level of tension and geopolitical risks, although Russia's retaliation is unlikely to involve any military measures. The reaction should be contained to economic channels as confirmed by the measures Russia has announced so far (such as imposing restrictions on imports from Turkey, advising its citizens not to travel to Turkey, etc). Although these are likely to have an impact on trade and tourism flows to Turkey in the short term, this will likely be only a moderate headwind on Turkey's growth, provided Russia does not cut off gas supplies to Turkey, which view as highly unlikely given the pressures faced by Russia as a result of sanctions.

Turkey's exports of goods and services (tourism) to Russia account for 0.4% of GDP. So far both sides have refused to cool down the rhetoric against each other, which prevents de-escalation of the prevailing political tensions. In this regards, UN climate change conference in Paris on Monday could provide a medium for both sides to engage in dialogue, potentially with the pressure of Western leaders. In absence of some progress towards de-escalation, this will continue to weigh on the market sentiment.

In Turkey, inflation is expected to accelerate to 7.7% in November and rise above 8.0% by the year-end. The government's plan to increase the net minimum wage by 30% y/y in 2016 worsens the inflation outlook. As a result, significant risks of inflation seen staying at about 8% in 2016, depending on how the minimum wage hike is structured. This already resonates into the medium-term inflation outlook as the November CBT expectation survey reveals. Wage-driven deterioration in competitiveness will likely weigh on TRY in the medium term.

In Russia, inflation was at 15.6% y/y in October and is on the precipice of a steep decline because of base effects as the RUB has stabilised. In November, inflation will narrow to 14.8% y/y, the first major decline since Q2 15 (up 0.65% during the month) and the deceleration will continue in December and Q1 16. CBR Governor Nabiullina indicated that she expects rate cuts to recommence at one of the next three meetings (11 December, 29 January, or 18 March). 

"While we have forecast that the rate cuts would start in December, we now see several risks that could lead to delays to the restart of the cutting cycle, including political uncertainty in Syria-Turkey, renewed tensions with Ukraine, and lower global oil prices putting pressure on the RUB. In any case, we foresee 250bp in cuts once the cycle starts. Against a backdrop of further loosening we continue to expect modest RUB weakness", notes Barclays.